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Why I'll Buy the Facebook IPO

The stock is cheaper than you think.

Facebook is priced reasonably enough that I'm considering buying shares when the company completes a rumored IPO next year.

Sound crazy? Maybe. Before you judge, consider that data published at The Wall Street Journal put The Social Networkon track to produce $487 million in profit last year. That's $0.22 for each of the company's 2.2 billion shares outstanding -- just enough information to get us started developing an earnings multiple.

First, we need a market value. SharesPost supplied one last month when it revealed that buyers were paying an implied $82.9 billion valuation to acquire shares of Facebook on its exchange, or $37.68 each assuming there really are 2.2 billion shares outstanding. I think it's fair to trust the Journal's reporting. In doing so here, I'm assigning Facebook a P/E ratio of 171.

And your point is?I know, I know -- that's a rich multiple. For comparison's sake, here are the eight tech stocks that Capital IQ says trade for even richer premiums:

Company

P/E Ratio

3-Year Revenue Growth

Applied Micro Circuits

296.2

0.3%

Constant Contact(Nasdaq: CTCT)

291.2

51.1%

Synchronoss Technologies

281.7

10.3%

Anadigics

278.0

(2.0%)

Pegasystems

275.3

28.4%

salesforce.com(NYSE: CRM)

252.5

30.3%

Quantum Corp.

243.2

(13.1%)

Riverbed Technology(Nasdaq: RVBD)

190.0

32.7%

Source: Capital IQ, a division of Standard & Poor's.

Some of these stocks have provided brilliant returns for shareholders even as the market has spent the last three years losing ground. Both Riverbed and salesforce.com have more than doubled. Constant Contact is up more than 60%.

My point isn't that premium-priced stocks tend to outperform, though they often do. My point is that some businesses grow fast enough to defy not only conventional valuation metrics but also turbulent markets. Facebook looks like that kind of business today.

Look at the numbers. Revenue is up 128% annually over the past three years -- from $150 million in 2007 to $1.8 billion last year. So while salesforce.com trades for a significant premium to Facebook on an earnings basis, it's Facebook that's grown faster. Four times faster, in fact.

The importance of being socialTo be fair, some of this may have to do with the long tail of social media. Twitter is growing at breakneck speed and now trades for a premium to Facebook. Social gaming specialist Zynga is seeking $500 million more in financing at an implied $10 billion valuation. And don't forget Groupon, which for a time had a $6 billion grip on Google.

Social media is growing as fast as any business you'll find. Researcher BIA/Kelsey says social media advertising will account for $23 billion in spending this year alone. Facebook should claim a big share of that, with EMarketer pegging the total at roughly $4 billion.

Now here's why I'm interested in Facebook's IPO. Goldman Sachs recently put clients into Facebook at around $50 billion. I can't see the IPO market paying much of premium to that, if any.

There's no rule that says late private equity buyers must see a return on the first day of trading. Just ask Harris & Harris(Nasdaq: TINY). The nanotech venture capitalist had valued its pre-public shares of NeoPhotonics(Nasdaq: NPTN) at around $16.83 apiece only to see the stock come public at $14 a share.

Here, have a cocktail with that valuationWe don't know exactly how many shares Facebook would issue, but dividing a $50 billion market value by $487 million in earnings yields a P/E of 102. Yes, that's high, but it's also nowhere near as pricey as the multiples assigned to many of Facebook's cloud computing peers. And most of those are smaller, slower-growing businesses.

In other words, buying Facebook at the IPO should amount to buying a quality company at a premium yet justifiable price. Exactly the sort of formula we've employed for six years at Motley Fool Rule Breakers, with market-beating results.

Now it's your turn to weigh in. Would you buy a piece of Facebook at the IPO? Please vote in the poll below and then leave a comment to explain your thinking. You can also follow the Fool on Twitter or become a fan on Facebook.

Author

Tim Beyers first began writing for the Fool in 2003. Today, he's an analyst for Motley Fool Rule Breakers and Motley Fool Supernova. At Fool.com, he covers disruptive ideas in technology and entertainment. Find him online at timbeyers.me or send email to tbeyers@foolcontractors.com. For more insights, follow Tim on Twitter.